Is It Possible to Make Consumer Credit More Transparent?

Commenter Gray Hobo says:

It's not really transparency if the consumer can't understand it. Sure, a lawyer may draft language which appears to satisfy the regulations, but unless the consumer is prepared to hire an attorney to interpret the little "agreement updates" the objective is not met. Might we be better off by eliminating the regulations? Certainly we'd save some costs here and there, but I don't trust my card issuers to implement transparency on their own. The financial institutions have earned the distrust of their customers, and now we're all going to pay the penalty for that.

To which commenter SPQR9 replies: 

I used to regularly get calls from people claiming that the mortgage company had "defrauded" them - usually by selling them a variable rate mortgage that the caller would claim that they insisted they did not want.

Every time, I'd ask them to fax me the mortgage papers. And every time, at the first page of the fax would be the loan disclosure form that stated in large bold letters that the loan was a variable rate loan. And every time, the caller's signature would be on that page.

I think people really underestimate the degree to which there was transparency in the old system--at least about the major things (is this a variable rate loan)?  Credit card offers have long required simple, upfront statements of the terms; arguably, these could be improved (even more arguably, they have been by recent rule changes), but it's simply not the case that banks didn't inform people that they had variable interest rate loans that would reset--if they, or more likely the mortgage broker, actually hid the terms, then they were in violation of existing rules that we should enforce.

But most financial journalists have had the experience that David Leonhardt described last year:

During the great housing bubble and bust, journalists spent a fair amount of time searching for the perfect mortgage victim. This victim would be someone who played by the rules, took a conservative approach to his finances and simply wanted a decent place to live. He made his monthly payments on time, right up to the day that the bank informed him that his payments would balloon because of a fine-print technicality that no borrower could have understood. Just like that, the homeowner was facing foreclosure.

By and large, these searches failed. The stories of the housing bust tended to be more complicated. Many borrowers stretched to buy homes, figuring that they would be making more money soon enough or that housing prices would keep going up. In Southern California, one homeowner told me he was well aware that his monthly payments would eventually balloon. He thought everything would work out, though, because he assumed that ever-rising home values would allow him to refinance. Much of the country shared this belief.

Banks, mortgage brokers and real-estate agents were only too happy to encourage these fantasies, of course. In many cases, their encouragement crossed the line into malfeasance. But the bubble grew as large as it did because this malfeasance fed on human frailty, naïveté and even irresponsibility.

I think many people, like SPQR9's would-be clients, have genuinely forgotten that they were informed.  (Okay, maybe a few of them knew damn well that they'd been informed, and were hoping to get one over on the bank.)  A closing is a flurry of excessive information, much of it generated by early regulatory efforts to ensure that customers are fully informed.  Even though there's a term sheet right on top with the most relevant metrics--APR, points, variable or fixed, and regular monthly payment--they often don't even see this much.  They're overwhelmed.  So they stop reading.  There's only one piece of information they really took away: "if the the bank wants to lend me so much money, so it must be safe."

When it turned out not to have been such a good idea, they think back and they don't recall the mandatory disclosure that the rate was variable or that there was a prepayment penalty; they just remember being told that they could afford the payment.    Since they clearly remember being told it was safe, they figure that they must have been somehow defrauded.

I don't know what to do about this.  More disclosure just means more blindness. The best thing to do would be to stamp on every page, in big red letters, "Just because the bank is willing to lend you this money, does not mean that borrowing it is a good idea!"  But I'm not sure borrowers would read that either.